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Let’s Talk Valuation

It’s the topic that’s on everyone’s minds, but neither side wants to move first. It can be a sensitive subject and really put the brakes on an otherwise quickly-advancing relationship. It’s the elephant in the room and tends to hang around longer than necessary.

I’m talking about valuation — so what do you think your business is worth?

It’s not an easy conversation to have. So often it gets pushed aside until it’s impossible to avoid. According to most “good” negotiation tactics, it’s best not to be the first side to set a marker — will you come in too high or set the bar too low? Unfortunately, when both sides are following this methodology, deal momentum can sputter or stall out altogether.

I LOVE when an entrepreneur has a clear vision of what they want a transaction to look like, and is able to clearly describe that to me (ballpark valuation included). Sometimes, it is a number based on a specific data point they have (acquisition offer, the last round’s post-money, etc.), and other times it is just a gut feeling or even a hope of where the deal should be priced at. In either case, from my perspective, it is super helpful. With that piece of information, paired with additional data about the business, we can figure out if continuing the dialogue is a good use of everyone’s time. That doesn’t mean we’ll agree with the figure right away or even ultimately, but simply that we believe there is a reasonable path to getting close to their goal based on the data we have today and the information we expect to receive in the future. This can save a lot of time for both entrepreneur and VC, and the quicker the transaction moves towards a close the faster the management team can go back to refocusing 100% of their efforts on running the business, rather than closing a new round of funding.

To be quite honest, the above rarely happens. It’s far more common for negotiation to devolve into a dance between the VC and CEO to see who is going to commit to a figure first. Many times I’ll try to back into the answer by asking about the ideal investment amount and the dilution they’re willing to take on. Sometimes we can get to a range that way, which can suit the purpose of keeping the conversation going. But the usual response to that is, “We’re going to let the market figure that out.” Sometimes the entrepreneur will ask, “So, based on what you know about my business, what type of valuation would you place on it?” This can be a very difficult question to answer, and it usually results in a very large range of valuations that may or may not appease the entrepreneur’s request. Many times, we simply do not have enough data to provide an accurate picture of what we’d be willing to pay without really digging into the details (customer references, management meetings, financial/pipeline review, etc.).

Honestly, I don’t have a great answer on how to get clarity around this topic more quickly. Many times it simply comes while continuing to build the relationship and while learning more about the business and market opportunity. And maybe that is the most appropriate way for it to play out – the more we get to know a business, it’s team, and it’s potential, the higher the valuation we’re willing to pay. Similarly, the more CEOs get to know OpenView and our unique approach to adding value post-investment, chances are the more willing they’ll be to move a bit away from that initial number they had pegged in their minds if they feel we are the right partners. Perhaps this is the way the valuation gap naturally closes.

Obviously, I think both sides would prefer to figure out if there is a good “deal fit” earlier in the conversation rather than later, but to me, it’s not clear there is always an efficient and accurate way to figure that out without building the relationship first. Please chime in with any suggestions — I’m all-ears and eager to see if there is a more preferred method by both VCs and entrepreneurs.

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Ricky Pelletier focuses on identifying and analyzing various market and investment opportunities. As a VP, he works with other members of the OpenView investment team to structure and conduct diligence on new investments. Ricky is a Board Director at Intronis and Open-E, and is active as a Board Observer at Spredfast and FieldAware.

http://twitter.com/akibalogh Aki Balogh

Ricky — one way to efficiently back into this is to discuss whether the entrepreneur sees the investment as financial or strategic. If financial, it then becomes easy to agree on a metric. If strategic, then you can discuss the exit strategy and determine viability that way.

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